(Bloomberg) — Plans for a big increase in the UK minimum wage threaten to make it harder for the Bank of England to cut interest rates and dampen longer-term growth, experts warned.

Prime Minister Keir Starmer’s new Labour government on Wednesday promised to bring in “a genuine living wage that accounts for the cost of living” and lower the eligible age to 18 from 21 as part of raft of legislation in its first King’s Speech to “unlock growth and take the brakes off Britain.”

Alongside an overhaul of employment laws that give workers unfair dismissal rights from day one and end fire-and-rehire, it confirmed that the minimum wage will rise faster than planned. 

The last Conservative government set the National Living Wage for 21-year-olds and over at two-thirds of the median wage. The Resolution Foundation think tank estimates that Labour’s plans would take that to 70%. 

Lowering the age of eligibility to 18 to “remove the discriminatory age bands to ensure every adult worker benefits” would cover an additional 1 million workers and give those on the current minimum for 18 to 20-year-olds an automatic 33% uplift. The government said the “changes will improve the lives of working people across the country.”

Sanjay Raja, chief UK economist at Deutsche Bank, said the proposals imply an increase of 7%-10% in the minimum wage from April 2025, which would come on top of two successive years of near-10% rises. That could have “a meaningful impact” both on inflation and unemployment, he added.

Vicky Pryce, chief economics adviser at the Centre for Economics and Business Research, said the pay plans would affect the BOE’s immediate stance on rates “as they anticipate higher inflation.” 

Where policymakers might have cut three times in coming months “instead they may cut twice,” she said. Higher rates could also end up “slowing growth, upsetting Labour’s plans” for a stronger economy. Economists at Goldman Sachs and HSBC have also warned about the risk of slower rate cuts. 

Two years of big increases in the minimum wage have already had an impact. The BOE blames the uplift for some of the UK’s sticky services inflation. Wages are a large share of the cost base for hospitality, retail and leisure industries and firms are passing those costs on.

In April, the minimum wage rose 9.8%, which followed a 9.7% increase in 2023. If the increase in 2025 is almost 10% again, it will be the first time it has risen roughly 30% over three years since it was introduced in 1997, Raja said.

Pryce said pubs are now going out of business because they can no longer pass on the pay rises and Raja said the higher costs have contributed to recent increases in unemployment.

Since April, the minimum wage has been £11.44 an hour for those aged 21 and over. The Living Wage Foundation estimates a real cost of living wage would be £12 an hour, an increase of 4.9%. The 18 to 20-year-old rate is currently £8.60 an hour.  

Raja said median pay is on track to rise by at least 4% next year and the government’s plans would add to that. Labour said its plans will be overseen by the Low Pay Commission, the independent body that sets the rate. 

–With assistance from Andrew Atkinson.

©2024 Bloomberg L.P.